A compact case for the model-building necessity of the exchange generalization featured on this website can be constructed on three robust characteristics of modern, highly specialized economies. (1) Workplaces restricted by substantial employer-employee information asymmetry broadly exist. (2) Downward nominal wage rigidity in the context of stationary cyclicality broadly exists. (3) Chronic wage rents, a phenomenon about which the macro academy is apparently uninterested, also broadly exist.
Information-challenged workplaces. Given a push from George Akerlof, economists learn early in their careers that rational pricing in the context of unbalanced buyer-seller information is deeply problematic in market-centric modeling. The well-known dictum has become an unhappy paradox, both indisputable and typically ignored. The two-fold objective of the GEM Project responds to that negligence: first, by rooting nonconvex Workplace Exchange Relations (WER) in the neoclassical tenets of optimization and equilibrium and, second, by demonstrating that the information-challenged workplace venue of price-mediated exchange is a necessary condition of stabilization-relevant, rational-behavior macro theory. The immodest ambition of rigorous workplace analysis is to join Kartik Athreya’s (2013) grand progression of big ideas that have propelled the development of rational-behavior, stabilization-relevant macroeconomics.
Downward-rigid wages. DWR is defined by its capacity to rationally suppress nominal wage recontracting over stationary business cycles. Such wage rigidity has long played a controversial role in macro theory. Lacking optimizing nonconvex WERs, effective suppression of recontracting by both Early and New Keynesians has always needed to be assumed.
The profession’s failure to complete the workplace-oriented agenda of efficiency-wage research is made especially frustrating by the abundant evidence supporting nonconvex WERs. Employers have long believed that dissatisfied workers, given the latitude, adversely alter their behavior on the job. An early Yankelovich poll of business leaders asked: Does job dissatisfaction lead to high turnover, tardiness, loafing on the job, poor workmanship, and indifference to customers and clients? Of the 563 respondents, 94 percent thought that such an association exists. Getting closer to the crucial macro question, Campbell and Kamlani (1997) surveyed 184 compensation executives at large firms, asking how much workplace productivity would decrease if wages were cut by 10 percent. The mean response was 20 percent. Nearly 7 out of 10 believed that the principal reason for the harmful effect is damaged loyalty. Moreover, most thought that labor cooperative input would be most harmed if employees believe that their employer is profitable and least affected if there are credible financial losses that threaten jobs.
The most persuasive evidence comes from Truman Bewley’s careful, in-depth interviews of 104 business leaders, asking why worker morale matters to them. The nature and incidence of their responses are telling:
Reason Percentage of Businesses Citing the Reason
Low worker productivity 89%
Poor customer service 14
Turnover 13
Recruiting 7
Absenteeism 4
Unionism 3
From Bewley: “Employers were reluctant to cut pay because they believed doing so would hurt employee morale, leading to lower productivity and current or future difficulties with hiring and retention. It was thought that these effects would in the end cost more than the savings from lower pay.” When asked to explain their labor-pricing practices, including the reluctance to cut wages, employers describe (once translated into GEM terminology) their active management of nonconvex WERs.
Pure wage rent. Nonconvex WERs additionally imply that PWR is a chronic outcome of price-mediated exchange in information-challenged workplaces. The descriptor “pure” distinguishes such rent from more familiar but less fundamental versions that the literature associates with labor unions, regulated firms, or (in a tiny way) market frictions studied in search/match modeling. PWR, unlike baseline DWR, demonstrates limited two-way flexibility. It also differs in having little prior presence in mainstream macroeconomics. PWR is arguably the macro academy’s biggest elephant in the room. Its existence is predicted by rational behavior, is supported by the available evidence, and is profoundly impactful
Like DWR, pure wage rent is a powerful fact in search of a worthy theory. The best, still relevant, empirical analysis of labor-price rent occurred decades ago, indicative of the void resulting from the inattention to wage rigidities during the mainstream run of market-centric New Keynesians. Katz and Summers (1989) used the U.S. Current Population Survey to demonstrate that employees receive substantial wage rents as a result of working in particular industries. K&S estimated the average rent in industries that pay premiums to be 28%. Controlling for worker characteristics reduces their estimate to 15%, but that adjustment requires caution. If firms use existing chronic wage rent to cream job applicants, as they surely would, 28 percent is likely closer to the true PWR. K&S show that accounting for fringe benefit or occupational differences tends to increase, not reduce, the wage differential.
Wage rents are also not simply caused by unionization. K&S find similar magnitude rents are paid to nonunion workers. How about Adam Smith’s famous argument, i.e., relatively difficult working conditions being a cause of relatively high labor pricing? K&S present evidence indicating that industries paying wage rents tend to have better working conditions.
K&S then use longitudinal data, focusing on worker movement from low- to high-wage industries, to identify another interesting fact. Relocating employees immediately pocket 60 to 100% of the industry wage differential. That new hires quickly capture most or all the existing rent undermines the argument that higher labor pricing reflects undetected acquisition of specific human capital. The evidence identifies the nature of rent-paying industries. They are capital-intensive, large scale, highly specialized, and restricted by costly asymmetric workplace information and routinized jobs.
PWR is the most mainstream-disruptive outcome of GEM theory. Continuous wage rent requires scrapping Keynes’s Second Classical Postulate and Euler-theorem income distribution while supporting the existence of pure profit. LEV labor-rent motivates long job tenure and the persistence of cyclical unemployment. More consequentially, PWR’s rationing of good jobs and the hours on them pushes both SEV and LEV workers chronically of market equilibrium.
Implications for stabilization policymaking. Taken together the three facts imply that contractions in nominal aggregate demand rationally induce mass involuntary job loss. They further imply that stationary contractions produce temporary spikes in unemployment while nonstationary total-spending collapse produces more substantial permanent job downsizing. They also imply that both classes of unemployment are highly concentrated in large, highly specialized workplaces. Moreover, in that venue, chronic wage rents rationally ration high-wage jobs, causing cyclical unemployment persistence and, much more consequentially, the persisting breakdown in the labor market’s capacity to equilibrate. The workplace-marketplace synthesis explains many more of the critical characteristics of modern, highly specialized economies than does mainstream market-centric analysis, surely making it the superior guide to stabilization policymaking.
Blog Type: New Keynesians
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